Evaluating the Value of Nondisclosure Agreements Under New Tax Reform Law

The new tax reform bill contains a wide range of changes that New Jersey businesses must consider. Some are not exclusively financial. In response to the increased attention on sexual harassment in the workplace, a provision was added to the Tax Cuts and Jobs Act that discourages companies’ use of nondisclosure agreements in harassment and sexual assault settlements.

As has been widely reported in the media, the alleged victims of Harvey Weinstein and Bill O’Reilly all executed nondisclosure agreements (NDAs) that prohibited them from publicly discussing their harassment claims. The agreements not only helped protect the reputations of their employers but also qualified as a tax-deductible business expense.

The Value of Non-Disclosure Agreements

The use of nondisclosure agreements or nondisclosure clauses is one of the best ways to shield such information assets from unintended disclosure. At the most basic level, a nondisclosure agreement is a contract. The parties exchange mutual promises, the disclosing party to release the confidential information and the receiving party promises to protect the confidentiality of the information disclosed. Non-disclosure agreements (“NDAs”) are useful in business acquisitions where the information of the target is protected from disclosure and unfair use by the acquirer. In the intellectual; property arena, NDAs provide an opportunity for a company to evaluate the IP without obtaining the right to use or copy it.

Through a nondisclosure agreement or clause, businesses can go a long way toward ensuring that their information stays confidential. In cases where information is wrongfully shared or misused, nondisclosure agreements should provide legal recourse, including at a minimum, the ability to petition the court for an injunction to prevent further disclosure. In litigation settlements, it is paramount that the settlement contains NDA language to prevent future disclosure.

Tax Cuts and Jobs Act

Under Section 162 of the U.S. Tax Code, companies are authorized to deduct ordinary and necessary expenses of conducting business, with certain exceptions. Accordingly, companies are generally able to deduct the payment of a judgment or settlement of a suit or claim arising out of a business matter, such as employment claims. Employers have also relied on this deduction to cover the costs of counsel defending such claims.

Internal Revenue Code Section 162(q) now expressly denies taxpayers the ability to deduct as a business expense any payment made: 1) in settlement related to sexual harassment or sexual abuse, or 2) for attorney's fees related to any settlement of a sexual harassment or sexual abuse claim if such settlement or payment is subject to a nondisclosure agreement. The new tax law provision applies to any payments made on or after December 22, 2017.

Notably, Section 162(q) does not define the terms “sexual harassment” or “sexual abuse.” It also does not address how to determine whether any particular payment would be “related to” such claims within the meaning of the new provision. We expect that the Internal Revenue Service will provide guidance on these topics in the near term. If the payment is non-deductible, the cost of settlement has become more expensive. What is clear is that public companies have their work cut out in order to explain settlement to the shareholders and auditors.

Considerations for New Jersey Businesses

The tax reform law adds another layer of analysis for businesses seeking to resolve sexual harassment claims. NDAs are an effective means of reducing the public relations fallout. However, they because they no longer have the same financial benefit, it may not make sense to add an NDA to every settlement agreement.

In cases involving particularly egregious or salacious allegations, the inability to write off the settlement may be inconsequential. However, in other cases, businesses should consider whether an NDA is worth the financial cost.

If you have any questions or if you would like to discuss the matter further, please contact me, James McDonough, at 201-806-3364.